1. The Zambian authorities welcome the completion of the 2013 Article IV consultations and the Board’s consideration. The authorities have had thorough and wide-ranging discussions with staff, particularly around the priorities of the new Government as it tackles the challenges of an unacceptably high level of poverty and inequality, whilst maintaining robust economic growth and macroeconomic stability. This concern has necessitated the adoption of a higher fiscal deficit profile over the medium term than was originally envisaged.
2. Whilst there are many areas in which the authorities agree with Fund staff, they do have areas of significant differences in terms of policy priorities and the emerging risks to strong growth and poverty reduction over the medium to long term. In particular, the authorities’ views differ from the assessment of Fund staff in several key areas: (1) outlook, risks and the fiscal stance; (2) public financial management (PFM); (3) monetary policy; and (4) competitiveness.
A. Authorities’ views on selected key areas
Outlook, risks, and the fiscal stance
3. The authorities’ projections for growth of an average of 7.5 percent over the medium term are consistent with those of the Fund staff. They are also looking to achieve fiscal consolidation over the medium term towards a deficit of no more than 3 percent of GDP. They do not, however, agree that such fiscal consolidation should be front-loaded. On the contrary, they believe that such front-loaded fiscal consolidation would substantially impair critical investment in the energy and transport sectors – investment that is critical for strong growth and improved competitiveness. In addition, the Government is committed to substantially improving education and health outcomes in terms of both the availability and quality of health and education services. Both of these actions are critical to reduce poverty and inequality and to preserve peace and stability that Zambia has enjoyed since independence.
4. The authorities acknowledge and agree with Fund staff that improving Zambia’s fiscal position will require fundamental reforms that enable them to contain the wage bill and recurrent expenditures, and boost their revenue base. They would, however, welcome greater engagement and more innovative thinking around how the Government can better balance the need to manage its wage bill against its commitment to improve health and education outcomes through improved services and infrastructure. They note that the health and education sectors account for approximately 70 percent of the civil service workforce. Be that as it may, achieving the MDG targets, such as improving maternal health and the education outcomes and opportunities for their children, will require more and better qualified teachers that will help to reduce pupil teacher ratios, as well as more health personnel to reduce the number of mothers giving birth without qualified attendants. The current health and education sectors are estimated to require additional 20,000 personnel each, if they are to achieve their MDG targets. While one way to address these challenges is improvements in labor productivity, such improvements will require greater use of technology (e-governance), which is expensive to implement and will need a medium- to long-term horizon to fully implement – with implications for the budget deficit.
5. In the authorities’ view, failure to undertake these tasks poses a bigger threat to Zambia’s long term growth prospects and the probability of reducing poverty and inequality than failure to implement front-loaded fiscal consolidation. Therefore, the fiscal stance that has been adopted by the authorities reflects the new Government’s strategy to address the constraints placed on economic growth by the low investments in infrastructure over the past years. However, the authorities remain committed to a tighter fiscal stance in the medium term, as the bottlenecks to growth are loosened.
Public financial management (PFM)
6. The authorities broadly concur with the views of Fund staff on the need to revitalize reforms that will help to improve the quality and effectiveness of their expenditures. This will require them to significantly improve their institutional framework and arrangements in the areas of cash and financial management, planning and budgeting, as well as investment planning and debt management. The authorities are committed to these tasks and have already engaged their international cooperating partners for support. In 2014, for example, the Ministry of Finance will develop a planning and budgeting policy, and present a planning and budgeting bill to Parliament.
7. Zambia’s monetary policy has successfully reduced inflation, whilst maintaining a flexible exchange rate regime, as evidenced by the achievement and maintenance of single-digit inflation. In addition, recent work by Fund staff, suggests that the exchange rate is not misaligned. Therefore, the authorities are concerned that Fund staff continues to advocate for greater flexibility in the exchange rate, when the Bank of Zambia (BOZ) has allowed the exchange rate to fluctuate – sometimes significantly, such as during the global financial crisis. The BOZ currently intervenes to contain excessive volatility, which undermines the primary monetary policy goal of achieving low inflation and more broadly economic growth. It should also be noted that regulations such as the Statutory Instrument (SI) 33 of 2012, which prohibits the pricing and quoting of domestic transactions in foreign currency, were intended to address the issue of dollarization and thereby strengthen the transmission mechanism of monetary policy.
8. The authorities acknowledge the concerns raised by staff on the potential adverse impact of recent regulations on the competitiveness of the Zambian economy. However, they believe that many of these concerns are misplaced. One of the key impediments to improving competitiveness in Zambia has been poor infrastructure and shortage of skilled labor. Staff in fact acknowledges empirical work that suggests that Zambia’s infrastructure deficit relative to its regional neighbors, such as Mauritius, potentially cost the country 2 – 3 percent of GDP per annum. The Government’s public investment strategy is squarely aimed at addressing these impediments. The authorities do not believe that the recent policy actions such as the increase in the minimum wage and strengthened monitoring of the external sector make the business environment worse. On the contrary, they believe that these actions will allow for productivity gains and improved macroeconomic management for the greater benefit of businesses and households.
B. Recent economic developments, outlook and risks
9. Despite several challenges, Zambia’s economy continues to grow strongly, anchored on sound macroeconomic policies and a favorable business climate. Output grew by 7.2 percent in 2012, and averaged 6.3 percent between 2004 and 2012, according to the October 2013 Regional Economic Outlook for Sub-Saharan Africa. Growth in 2012 was driven mainly by agricultural, construction, and communication sectors. At the same time, inflation has remained broadly consistent with expectations and was 7 percent in November 2013. In response, the Bank of Zambia’s Monetary Policy Committee decided in November 2013 to maintain its policy rate at 9.75 percent.
10. As a result of prudent fiscal policy management, budget performance has improved consistently over time, with the deficit excluding grants declining from 8.4 percent of GDP in 2004 to about 4 percent in 2012. Despite pressures from the recent wage increase, the authorities remain committed to a sustainable fiscal policy stance.
11. Meanwhile, the external sector position was characteristic of solid economic performance, with staff analysis not showing a real exchange rate misalignment. The current account was broadly balanced in 2012; and foreign direct investment strong. According to the REO (October 2013), FDI flows increased sharply and reached 5 percent of GDP in 2012, in response to rising copper prices and Zambia’s relatively favorable business environment.
12. The financial sector is characterized by profitable and well-capitalized banks. Private sector credit remains strong and non-performing loans are declining.
C. Request for waiver of non-observance of performance criterion
13. The Zambian authorities deeply regret the unintentional misreporting, and request a waiver for non-observance of a performance criterion (PC) under the ECF arrangement that expired in June 2011. As explained in EBS/13/147, the misreporting relates to two loans that were contracted during Zambia’s ECF arrangement, each with a grant element less than 35 percent.
14. In line with the Managing Director’s report, the authorities have explained the circumstances under which the Lusaka Stadium Project and the Mobile Hospital Project were not reported to the Fund at the time of the fifth and sixth reviews in December 2010 and June 2011, respectively. At the time, the two loans did not appear on the Ministry of Finance’s database, due to coordination gaps between different units of the debt management department. In addition, officers responsible for debt management had determined, prior to the contracting of these loans, that they would meet the 35 percent grant element threshold. However, based on revised calculations, they fell slightly short of the threshold.
15. The authorities are taking necessary action to strengthen debt management. To deal with the gaps in coordination, the Ministry of Finance have developed a Public Debt Procedures Manual, aimed at providing guidance and direction to all stakeholders involved in debt management. Also, the authorities have instructed government creditors to inform the relevant unit whenever a disbursement takes place. At the same time, relevant units now undertake regular bi-monthly internal reconciliation. Furthermore, the authorities are working on a broader Debt Management Reform Plan that was finalized earlier this year, in collaboration with the World Bank. The plan addresses key debt management issues, including strengthening of the legal framework, developing a debt management strategy, and improving operational risk management. The authorities have also committed to sharing with the Fund team the terms of all future external loan agreements prior to their signing, for a proper assessment of their concessionality.
16. My Zambian authorities have resolved to step up infrastructure development, to build on the economy’s strong track record of macroeconomic performance. Despite resource and capacity constraints, they will continue to work closely with the Fund and other international development partners in an effort to improve the welfare of the Zambians.